How Sustainable Is GameStop’s Digital Sales Scheme?

by Anthony John Agnello | February 13, 2012 1:19 pm

The writing is on the wall: by 2020, video games will no longer be something a person buys in a bricks-and-mortar store. The transition is already well underway. People are downloading their video games to Apple (NASDAQ:AAPL[1]) iPhones. In the living room, their LG (PINK:LGEAF[2]) and Samsung (PINK:SSNLF[3]) televisions have games built right in. They aren’t going into to Best Buy (NYSE:BBY[4]) to purchase new content for their Sims game—they’re buying new content directly in the game, whether through a Web browser or an iPad.

Or at least, you’d think consumers aren’t buying purely digital goods at stores. Leading U.S. video game retailer GameStop (NYSE:GME[5]), however, has sales figures that indicate otherwise.

Diversification into digital games, services, and additional content has been the fastest growing source of revenue for GameStop since the economic crash in 2008, when spending on games began to contract. While revenue during the 2011 holiday period came in at $3 billion, flat with the same period in 2010, the company’s digital business grew 60% year-on-year. This came after sales of digital products grew 69% year-on-year during the previous quarter, accounting for 42% of GameStop’s second-quarter profits.

With growth centered on the sale of non-physical goods, the evidence suggests that while GameStop will likely survive in the future as a business, it may not continue to exist as a bricks-and-mortar retailer. Speaking at the DICE (Design, Innovate, Communicate, Entertain) Summit last week, GameStop’s manager of PC digital distribution, Steve Nix, shared statistics that indicate GameStop will be able to survive even if it isn’t selling games on discs. “Seventy percent of our sales for DLC is non-credit-card,” said Nix, “So that’s a customer either paying with cash, GameStop gift card, or trade credit.”

All-important add-ons

DLC, or downloadable content, refers to additional content purchased for games people have already bought. In the case of Activision Blizzard‘s (NASDAQ:ATVI[6]) popular Call of Duty series, DLC refers to new arenas for people to play together in or subscription services like stat tracker and social network Call of Duty Elite. GameStop made investors smile last November when it sold 600,000 $50-per-year subscriptions to Call of Duty Elite within days of the service’s launch.

Extrapolating from Nix’s statements at the DICE Summit, then, of the estimated $30 million GameStop made selling Call of Duty Elite subscriptions in November (600K subscriptions at $50 apiece), $21 million came from purchases made in-store by customers using cash, gift cards, and trade-ins of physical goods. GameStop is actively growing a market that will keep customers frequenting their physical retail outlets even when there is no physical good to purchase.

Of course the problem with this setup is that part of those sales come from GameStop’s lucrative pawn system, whereby the store purchases used goods from customers in exchange for credit. Used goods account for a huge percentage of GameStop’s profits. Used-goods sales totaled $292 million in the second quarter, or 46% of the company’s profit for the period. If physical goods are traded in and that store credit is used to purchase digital goods, GameStop will presumably run out of used physical goods to sell at some point.

The next logical step then would be to accept digital trade-ins to make for a fully digital business ecosystem. Nix said at DICE that GameStop doesn’t plan to start reselling or buying back digital PC games any time soon. For now, GameStop seems to have a good system in place for its retail operation to survive in an all-digital market. But the question remains: for how long can it sustain that system?

As of this writing, Anthony John Agnello did not own a position in any of the stocks named here. Follow him on Twitter at @ajohnagnello[7] and become a fan of InvestorPlace on Facebook.[8]